Marco Hickey's  Instablog

As oil sold off over 6% Tuesday, I was searching for some companies to buy on the dip. I decided to look at opening the position with the buy/write option strategy, as this would give me a return if oil rallies, as well as protect my position to the downside if oil continued to slide. As recently stated on OptionMaestro.com, I believed oil would peak in early to mid July. However if we keep hearing of these "green shoots" and the stock market continues to rally, I believe oil could continue to rally as well, and as late as October in my opinion. I don't think $75 a barrel oil is out of the question, especially on the back of a weak dollar.

For this analysis I have gathered a list of the top fourty energy stocks (by market cap) from the S&P 500 index. I will outline an option idea on each stock which will provide a return (if crude oil/the market keep rallying and the stock is assigned at expiration), as well as downside protection on the stock (in case the market happens to sell off). I have also included 5 energy related ETF's. Therefore to understand this post, you'll need a general understanding of stock options. To learn more about options and, how options can help protect your portfolio, and allow you to speculate with less money up front; check out my book here.

All data as of market close Wednesday July 29, 2009.


The stocks are in order from greatest to least market cap. The first stock in the table below is Exxon Mobil (XOM) to understand how to read the table I'll give a worded example using XOM. The example assumes the stock was being purchased and immediately written out for the August options expiration.

Purchase Exxon Mobil (XOM) stock, and sell the in the money August 70 strike call option. The premium received from the call option would give a downside protection of 3.35%. If the stock is assigned at options expiration on August 22, 2009 the total return from this position would be 2.86%. The current options market is factoring in a 64.4% probability Exxon Mobil will be at or above 70 a share by the August options expiration.

Company	Ticker	Strike	Return %	Protection %	Probability %
Exxon Mobil Corporation	XOM	70	2.86	3.35	64.4
Chevron Corporation	CVX	70	6.19	1.05	26.6
ConocoPhillips	COP	45	6.14	1.14	26.1
Schlumberger Limited	SLB	55	6.84	2.06	33.5
Occidental Petroleum Corporation	OXY	75	8.78	0.83	18.8
Apache Corporation	APA	80	5.30	2.63	40.9
Devon Energy Corporation	DVN	60	9.87	1.39	25.9
Anadarko Petroleum Corporation	APC	49	7.73	1.90	30.9
XTO Energy Inc.	XTO	40	5.49	2.37	37.9
Marathon Oil Corporation	MRO	32	6.12	2.43	40.4
Halliburton Company	HAL	22	5.00	3.15	44.6
EOG Resources, Inc.	EOG	75	7.38	1.59	28.8
Hess Corp.	HES	55	7.95	1.60	27.9
National-Oilwell Varco, Inc.	NOV	36	6.04	3.01	41.4
Southwestern Energy Company	SWN	42	7.94	2.75	37.2
Chesapeake Energy Corporation	CHK	21	6.32	4.28	46.7
Diamond Offshore Drilling, Inc.	DO	95	6.53	1.74	31.6
Baker Hughes Incorporated	BHI	40	5.70	2.95	41.5
Spectra Energy Corp.	SE	17.5	1.63	2.99	61.1
Murphy Oil Corporation	MUR	60	7.46	1.85	30.9
Noble Energy, Inc.	NBL	60	7.57	1.68	29.5
Williams Companies, Inc.	WMB	17.5	9.10	1.54	24.6
Valero Energy Corporation	VLO	18	6.26	2.87	44.6
Peabody Energy Corporation	BTU	33	6.49	4.04	46.5
Range Resources Corp.	RRC	47.5	7.29	1.71	30.4
El Paso Corporation	EP	10	6.15	3.59	44.1
Cameron International Corporation	CAM	30	4.90	4.84	52
CONSOL Energy Inc.	CNX	35	8.36	3.88	40.9
Ensco International Incorporated	ESV	40	9.28	1.35	24.3
Smith International, Inc.	SII	25	7.98	2.94	36.7
FMC Technologies, Inc.	FTI	45	8.72	1.50	26.3
Nabors Industries Ltd.	NBR	17.5	10.39	2.16	29.1
BJ Services Company	BJS	14	5.99	3.65	45
Denbury Resources Inc.	DNR	15	3.36	8.24	67.1
Cabot Oil & Gas Corporation	COG	35	5.60	3.50	44.8
Pioneer Natural Resources	PXD	30	15.05	1.33	19.4
Sunoco, Inc.	SUN	25	5.53	2.27	38.7
Rowan Companies, Inc.	RDC	20	3.74	6.56	62.2
Massey Energy Company	MEE	25	8.07	5.15	46.2
Tesoro Corporation	TSO	14	12.34	2.97	33.3

ETF	Ticker	Strike	Return %	Protection %	Probability %
Energy Select Sector SPDR (ETF)	XLE	52	6.29	1.11	25.4
United States Natural Gas Fund, LP	UNG	13	9.21	5.05	44.3
United States Oil Fund LP (ETF)	USO	35	7.05	2.48	36.2
ProShares Ultra DJ-UBS Crude Oil(ETF)	UCO	11	12.66	4.71	38.4
ProShares Ultra Oil & Gas (ETF)	DIG	29	7.44	3.23	39

All of these options expire on August 22; therefore the last trading day is Friday, August 21, 2009.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

This strategy will give protection if the market sells off, as well as provide a return if the market continues to rally. If the stock is not assigned, this strategy is a great way to create additional income for your portfolio. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: Long DIG, HES, UCO